LT, here's that article on German interest rates. You say they can't cut, but this article implies otherwise. How does this affect your outlook for gold and the dollar?...
Euro Markets: *Special* As Global Financial Storm Builds, Whispers of German Rate Cut Are Heard
archive.thestreet.com
By Ned Stafford
Special to TheStreet.com
10/2/98 12:15 AM ET
FRANKFURT -- Bundesbank key rates are desperately trying to cling to a very steep and slippery slope. A little more than a month ago, most believed the Bundesbank would have to raise rates this fall. But that thinking has slid quickly in the opposite direction. Instead of betting on a rate hike, most investors now believe the German central bank will keep its key repo rate at 3.3% until European Monetary Union kicks off on Jan. 1.
Indeed, German central bank officials have stated that they have every intention to keep repo rates steady for the remainder of the year. But a lot can happen in three months, especially in the increasingly volatile financial markets. For instance, it took less than three months for Fed chief Alan Greenspan switch from a tightening bias to cutting rates.
Hans-Juergen Meltzer, economist at Deutsche Bank in Frankfurt, said a Bundesbank rate cut could not be ruled out. "Three months is a long, long time," he said, pointing to the intensity of the financial storms that are now lapping on rich-country shores.
The decline in European stock markets can no longer be viewed separately from the economy, and might be telling us of a much bigger economic slowdown than currently forecast. Meltzer, pointing at Thursday's 7.6% plunge in the Xetra DAX, said: "This is disastrous. The markets are in real trouble now."
The persistence of strong gains in both U.S. Treasuries and European government bonds has started to fuel fears that bigger problems are afoot than the standard market hiccups.
Underscoring market concerns, the Fed is expected to cut rates again this year, most probably at the next FOMC meeting in November. That would put tremendous pressure on the ailing dollar, which already is getting trading close to 1.60 marks. Anything below that level might spur European central bankers to action. Many EMU advocates hope to start with the dollar around 1.80 marks.
While many anticipate outer European countries to lower rates as part of EMU convergence plans, pressure is mounting on Germany to cut its own rates, with the International Monetary Fund to the newly elected government in Germany calling for rate-cutting action in order to stave off economic problems. And the French, beset by high unemployment rates, probably would quietly cheer a Buba rate cut. And you can be sure that ECB President Wim Duisenberg and Bundesbank President Hans Tietmeyer will get an earful of advice in Washington in coming days at G7/IMF meetings.
The main argument against a Bundesbank rate cut is the aforementioned need for convergence before the EMU begins at the beginning of next year. On Jan. 1, 1999, Italy, Spain, Portugal and Ireland -- with rates now ranging from 4.25% to just over 6.0% -- must accept the ECB key rate, and most believe that will be the current Bundesbank repo rate of 3.3%.
The LIFFE three-month Euromark contract, a key indicator of market sentiment toward the Bundesbank repo rate, is now signaling the German central bank will not cut rates before it goes out of business Jan. 1. The December Euromark contract Thursday closed at a yield of around 3.52%, and the contract normally trades 20 to 25 basis points above the repo rate.
But after the ECB takes control, matters may swiftly change. The March contract ended Thursday's session with a yield around 3.35%, indicating strong market sentiment that the ECB will cut rates early next year, and that Italy and the other high-interest-rate nations will have to adapt to that lower rate.
The four high-interest-rate nations have not budged since May, and Duisenberg and Tietmeyer in recent weeks have basically ordered them to start cutting rates. Many expect cuts to start as soon as next week. Stefan Bergheim, economist at Merrill Lynch in Frankfurt, said, "We believe rate cuts are imminent, and that they will be big."
That would reduce the hurdle for a Bundesbank rate cut, an important consideration as the global financial crisis creeps closer. The four high-interest nations total less than 30% of Euroland GDP, while Germany and France combined add up to nearly 60% of Euroland GDP. In other words, the Bundesbank is likely to act in core Europe's best interests.
And problems are mounting. Adolf Rosenstock, economist at Nomura International in Frankfurt, said economic danger signals were sprouting up around Europe -- and rapidly. "My economic reports nowadays do not have a very long shelf life."
His latest revision puts German 1999 growth at 2.0%, down from consensus forecasts just a few months ago of 3.0%. And he admitted the risk of his forecast was "very much to the downside." Morgan Stanley Dean Witter already pegs German 1999 growth at 1.5%.
One of Rosenstock's favorite economic indicators -- the IFO diffusion index of business sentiment -- fell sharply in August to -0.6% from +2.1 in July, indicating a shift to pessimism about the future. And Rosenstock said the August survey was taken just as the Russian crisis flared up, meaning that businesses had not yet digested the full negative implications of the emerging markets crisis. "The September number will be much worse," he said.
Rosenstock also sees trouble in France, but said the outlook in Italy and the U.K was alarming. A technical recession -- two quarters of negative growth -- is likely in the U.K. next year, and possibly late next year in Italy. "I think Italy is really the weak link right now in the European chain."
Will the Bundesbank cut rates? "My fear that things will turn worse tells me they will have to. But my rational thinking tells me, that because of EMU convergence, they will not."
Bergheim, of Merrill Lynch, also does not see a Bundesbank rate cut. But he, nonetheless, sees several economic danger signs, and describes Germany, not Italy, as the "weak link" of Europe. His favorite economic indicator is the Inventory Assessment index, which he said "is showing a mass deterioration."
In August, it was at 9.0%, meaning the percentage of companies with inventory too high is nine percentage points above companies with inventories too low. The index has risen from 0.4 in February.
German export growth peaked in September of last year at the start of the Asia crisis, and has slipped since. Bergheim sees growth turning negative soon. "And that is bad news."
The September BME/Reuters PMI released Thursday showed that growth slowed for the third month in a row, falling to the lowest level since October 1996.
And then there is the big, bad D-word, which most economists do not like to discuss. German export prices in August were down 0.5% on the year and import prices down 4.7%. The German producer price index fell 0.8% in August, and CPI in September was up only 0.8%.
Bergheim said the drop in prices thus far have benefited German consumers, adding that deflation would become a problem "only if central bankers make a huge mistake."
Like what kind of huge mistake?
"Not to cut rates soon enough if necessary."
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